Sept 23 (Reuters) - Tesla Inc Chief Executive Elon Musk urged investors to approve the 2016 purchase of SolarCity at a big premium to its market value despite knowing the solar installer faced a cash crunch and publicly stating he had recused himself from involvement in the deal, according to court documents unsealed on Monday.

The filing was part of a lawsuit by Tesla shareholders alleging the company’s board breached its duties to investors by approving the $2.6 billion acquisition of the struggling company, which was run by Musk's first cousins and of which he was a chairman and the largest stakeholder. The former SolarCity operations have been a drag on Tesla, with panel installations slumping since they were acquired.

Defendants asked the Delaware Court of Chancery judge to dismiss the case before it heads to a trial in March. Shareholder lawsuits that survive a motion to dismiss often settle before trial, which in this case might involve a payment to shareholders by Musk as well as money from directors’ insurance.

Tesla rejected the allegations in an emailed statement, saying they were "based on the claims of plaintiff's lawyers looking for a payday, and are not representative of our shareholders who support our mission and ultimately voted in favor of the acquisition."

The suit represents another legal headache for Musk, the high-profile entrepreneur who settled a lawsuit by U.S. securities regulators last year over his use of Twitter and is being sued by for defamation by a British diver who said Musk falsely branded him a pedophile. Just last week, a Delaware judge ruled that Tesla must defend at trial Musk's multibillion-dollar pay package.

According to the filing, Musk was informed at a SolarCity board meeting in October 2015 that SolarCity needed to raise up to $300 million and was slashing its solar installation forecast for the year. The company issued $113 million in convertible notes a month later, of which Musk bought $10 million.

By February 2016, SolarCity management told the board its cash balances were forecast to drop below amounts required for a key line of credit for several months of the year. A default on that line of credit would trigger defaults on other debt instruments, the filing said.

Despite the bad news, Musk proposed the acquisition of SolarCity to the Tesla board later that month after a Lake Tahoe family vacation with his cousin, SolarCity Chief Executive and founder Lyndon Rive. SolarCity did not disclose the details of its liquidity concerns to investors.

At a meeting of Tesla’s board on June 20, 2016, Musk advocated to fellow board members an initial acquisition price of $28.50 per share for SolarCity - a 30% premium to its market price - even though Tesla's financial adviser, Evercore, had recommended $25 to $27 a share.

The board ultimately approved an exchange ratio that represented a share price of $26.50 to $28.50 a share, though the offer was lowered later prior to the deal closing.

Tesla said Musk's meetings with Rive, his involvement in discussions about valuation, and all other material information were accurately described to shareholders in public filings before the deal closed.

Once Tesla made the offer for SolarCity on June 21, Musk publicly recused himself from the deal. But according to the filings he held frequent meetings with Evercore and pushed investors in a series of phone calls to support the purchase.

"I could not be recused from all discussions ... I needed to voice my opinion, obviously," Musk said during questioning under oath by lawyers for the suing shareholders.

In the meantime, Musk assured Rive that he would "have covered" with respect to cash needs until the acquisition closed as SolarCity "was running crazy close" to its liquidity covenants, the documents said.

The companies said SolarCity accepted the offer on Aug. 1, 2016. The stock swap offer valued SolarCity at $25.37 a share, less than the initial proposal, and in line with the Evercore proposal. Shareholders approved the deal on Nov. 17. (Reporting by Nichola Groom; Editing by Tom Brown)